What if somebody gave you an interest-free loan for a year? Say, the government, maybe. And then instead of requiring you pay back all of the loan, they only wanted half?
This situation actually exists within the Affordable Care Act / Obamacare in some circumstances. Throughout the year, Premium Tax Credits are paid directly to the insurance company based on our estimated income for the year. Then come tax filing season, we reconcile any differences – if our actual income is greater than estimated, we repay the excess on the advanced credits.
For the self-employed, seasonal workers, and retirees living off variable investment income, estimating income accurately can be next to impossible. As such, to provide some protection against unexpectedly large tax bills, as long as total income is less than 400% of the Federal Poverty Level (FPL) the amount of repayment is limited.
And those limits can have profound implications.
Obamacare Advanced Premium Tax Credit (APTC) Repayment Limitation
In the instructions for IRS Form 8962 (pdf) there is a nice table that outlines repayment limitations for excess advanced premium tax credits.
Here is the table for tax year 2018:
(2019 numbers slightly higher, but documents are still only in draft form.)
Line 5 of form 8926 translates total annual income to a percentage of the Federal Poverty Level. A non-single filing household with income of between 300% and 400% FPL might have to pay back at most $2,600, even if they underpaid premiums by $5,600, for example.
These repayment limitations mean there is an effective 0% ACA related tax rate on a range of incomes.
Here is a chart I’ve shared before, showing ACA premium reductions with increasing income for household size = 3 (2018 numbers.)
And here is what it looks like when the repayment limitation for the “At least 200 but less than 300” row in the table is reached around 250% FPL.
At 300% FPL, the repayment limitation jumps by an additional $1,050, which is a sort of additional subsidy cliff (shown as a $1,050 impulse in the chart.)
The repayment limit means additional income results in no reduction in tax credit (not required to repay the APTC), which is equivalent to a 0% tax rate.
(Hypothetical) Repayment Limitation Example
When I was exploring the tax / health insurance premium impact of moving to California, I estimated we would have income from dividends and interest of about $40,000/year, which is roughly 200% FPL for a family of 3. The remainder of our budget would come from selling stock, which could increase taxable income via realized capital gains.
If during annual health insurance enrollment in Q4 we estimated our annual income for the following year at just under 400% FPL, we might pay ~$7,600 for a Silver level insurance policy with high copays and a high $12,000 deductible.
But if we estimated our annual income at $40,000, then our insurance premiums would be only ~$2,000 and we would have a deductible of only $1,300.
Then, maybe on December 31st, I realize a capital gain of ~$40,000.
Since income was much higher than estimated, nearly 400% FPL instead of 200% FPL, we would be required to repay some of the advanced premium tax credits. But the ACA repayment limitation would cap this at $2,600. The cost-sharing subsidies never need to be repayed.
This chart has been shown before (in the post Harvesting Massive Capital Gains), where additional income beyond $40,000 for a family of 3 is taxed 3-fold (US Federal tax, California State tax, and ACA tax.) In most of the range of $40k to $80k income, taxes are 17%+.
And here is the same chart again, this time with the repayment limitation. The effective tax rate and total tax lines from the first chart are included for reference. In this case, tax rates above $40k are less than 15%
In this second chart, pay attention to the purple “Tax w/ APTC limits” line… as income increases above $40k we repay some of the advanced premium tax credit, up until the 200-300% limit is reached. At 300% there is a jump of $1,050 to the next threshold. (Throughout this range, California tax of 4% – 6% would apply.) Going over 400% FPL would require 100% repayment of all subsidies.
In Option A, we pay $7,500 in insurance premiums with a deductible of $12,000.
In Option B, we pay $2,000 in insurance premiums, $2,600 in premium repayment, and have a deductible of $1,300.
Option B saves $3,000 in premiums and over $10,000 in deductible, if applicable.
Option B is definitely the way to go then, right?
Rules, Requirements, Implications, & Penalties
I’ve been asked about this topic numerous times:
“I’ve had some unexpected income late in the year, and now my annual income will be significantly higher than I estimated due to:”
- an additional client,
- dividend increases and special dividends,
- unplanned expenses that required the sale of stock
- side hustle accidentally made extra income
“What do I do?!”
No worries here at all. Our best plans change. The rules were followed, so everything is fine.
Report the change to your State or Federal Exchange as soon as you know that income will be higher. This can be done as often as you want. They will respond with a redetermination notice, which is basically an adjustment to premium tax credits.
The implications can be long-lasting. Higher income this year might increase expectations on the part of the Exchange for higher income (and higher premiums) next year, thus preventing you from benefiting from cost-sharing subsidies. (In theory, I’ve not seen an example of this having happened.)
There is definitely a (perverse) incentive to estimate income on the low side.
Therefore, expectedly, the penalties for abusing the repayment limitations are severe: (legal text)
- knowingly and willfully providing false information.. may be subject to a maximum civil money penalty of $250,000 for each application
- Failure to provide correct information … where such failure is attributable to negligence or disregard of any rules or regulations may be subject to a civil money penalty for each use or disclosure of not more than $25,000
So, it is best to avoid giving the appearance of anything untoward.
But if income was going to go above a threshold anyway (so repayment is already limited), I wouldn’t hesitate to harvest gains up to the next beneficial threshold. But I would definitely avoid doing this repeatedly or making a pattern of it.
Obamacare / ACA tax credits are paid in advance based on estimated income, then reconciled the following year at tax time.
If actual income is higher than estimated, repayment of the advanced credits may be limited. This has the effect of creating a 0% tax region up to 400% of FPL.
If income is going to go above a repayment threshold anyway, there may be some opportunity to harvest some gains at a 0% Federal / ACA tax rate.
In practice, it is probably best to estimate income a little high, but in the event that income is significantly higher than expected report changes to your Exchange to redetermine ongoing advanced premium tax credits.
For a detailed exploration of the ACA / Obamacare, and how tax credits are related to income, be sure to explore these two classic posts:
Request for Real-World Examples
Have you had some interesting experiences with health insurance premiums, tax credits, and fluctuating/unpredictable income?